401K to pay off some debt

[bamarulz01]

Hello, I started a new job at the beginning of the year. I haven't done anything with the 401K from my previous employer. I know I need to make a decision on what to do with it (I do realize rolling it over to my current employer may be the smartest idea). However, what if I withdrew from the 401K and used it to pay off some debt.....what are the negatives of doing this? Just a few personal notes,,,I'm 27, single, and the only other debt I have is a car note (and a bunch of student loan debt that will take forever to pay of anyway)..... any advice is appreciated. thank you

[gorrilla]

The biggest drawback to using 401k money to pay off debt is that 1.) you'll pay taxes on the money you withdraw, and b.) you'll pay a 10% tax penalty.  So, when figuring how much it will cost you add, what, 20-30%?

[errymay]

I would roll over to new employer and take out a loan.  I know my plan allows loans up to 50%, you pick the length of time to pay back (up to 5 years)  This way, no taxes and you are paying yourself back the interest

[Tuscani]

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errymay wrote:

I would roll over to new employer and take out a loan.  I know my plan allows loans up to 50%, you pick the length of time to pay back (up to 5 years)  This way, no taxes and you are paying yourself back the interest

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I agree.

[masdeocho]

I don't agree that you are paying the interest to yourself.  You are losing the interest that you would have made on the funds had you left them in the 401(k).  I'm not necessarily saying you shouldn't do it, but it's not as simple as a loan to yourself.

[Erik]

I would not recommend it unless you absolutely have no other way of paying your debts. Not only do you lose out on the interest you would have made on the account while the loan is out (in the last year i've made an annualized return of 15%), but there could be other ramifications if for some odd reason you don't keep this job for the length of the loan. If you have an outstanding loan and you leave your comapny you'll be on the hook to repay the whole thing probably within 30-60 days or it will be treated as a distribution. Since you are under 59 1/2 you'll be assessed the 10% penalty and it will be taxed as regular income.

BTW, You might want to look into rolling the money into a traditional IRA instead of your new employers plan. You might have better investment options that could potentially get you a better return.

[Noah_Bodie]

bamarulz01,

Check into whether your new employer will let you roll in other 401K money and then borrow against it. Some employers let you start contributing from day 1. Other make you wait. Some might give you a loan against the money you roll in on day 1. Other might make you wait.

A 401K loan makes a lotta sense, IMHO. The money stays invested in your 401K, you don't get hit with the 10% penalty (like you would with a cash out), you don't get hit with taxes on it (like you would with a cash out), the interest is usually very low (and taxes are usually very high), and the payments get made via payroll deduction so you don't have to worry about missing a payment.

[masdeocho]

On the  other hand ... imagine you start your new job and the first thing you do is tell them you gotta borrow from your 401(k).  Of course, you don't have to tell them what it's for, your boss may not know if it's a big company and only payroll deals with it, but it's not how I'd want to start out. Doesn't make the best impression. Just MHO.

[Noah_Bodie]

You don't necessarily have to talk with your employer for all these questions. On the loans, you will in all likelihood have to talk with the company managing the funds.

[bonddiva07]

I agree with the posts that advise you NOT to do this.  I am an avid reader of Suze Orman, not only does she strongly advise against it but this is also one of the biggest mistakes you can make.  The purpose of the 401k is to help fund your retirement, and many people want to take these loans out against it to pay off debt but the cost of it is too high.  You will be losing interest you would have gained if you left it alone, or if you withdraw it completely you will be taxed heavily!!!! Find any other way to come up with cash, garage sale, bake sale, etc. anything but taking money that you have been responsible enough to put away for your retirement.  My advice is DON'T DO IT!!!!  It's not worth losing close to half of the money to the government or selling yourself short on gaining interest.  Your 401k is making money through that interest, so let those dollars continue to work hard for you!!!!